This is the third part of a three part post covering the stocks that almost made the cut for the September 2007 newsletter. You can read part 1 and part 2 here and here. I am also updating the model portfolio by adding Marcus (MCS) to the portfolio.
Marcus Corp (MCS) is a company based in the heartland of America that operates a chain of hotels and resorts as well as 52 movie theatres playing movies on 628 screens. The company also manages hotels for third parties. I have written about Marcus multiple times on this blog and last wrote about it in a post titled Bring Out The Popcorn For Marcus Corp.
After selling Marcus from my personal portfolio for a gain of 23% last September, I decided to revisit the company when I noticed that a slate of movies such as Spider-Man 3, Transformers, Pirates Of The Caribbean: At World’s End, Bourne Ultimatum, and the surprising hit Superbad have done very well recently, making this the first summer ever to pull in more than $4 billion at the box office (pdf). I must confess that I am guilty of watching Superbad and if you like movies like Harold & Kumar Go To White Castle, you might like Superbad.
Based on the performance of movies this summer and others such as Beowulf and Eastern Promises that are in the pipeline for later this year, box office receipts in 2007 are likely to surpass receipts in 2006, which in turn were 4.91% higher than 2005. According to Media By Numbers (pdf), as of September 3rd, 2007 receipts are already 7.42% higher when compared to the same time last year.
With the advent of inexpensive large wide screen TVs and home theatre systems, the decline of a movie going audience that is willing to pay almost $10 per seat (in some parts of the country) and as much as $3 for a bottle of water has been widely discussed over the last few years. In this environment Marcus is not only thriving (sales increased 37.2% and net earnings increased 81.5% in the fiscal fourth quarter ended May 31, 2007) but recently acquired another movie theatre operator and is experimenting with novel ideas such as its new Majestic theatre in Waukesha, Wisconsin. The Majestic is a theatre that enhances the movie going experience by offering 72-foot wide UltraScreens, a made-to-order pizza shop, a lounge, a coffee shop and ice cream parlor and get this, child care. Marcus figured that if customers had plans for dinner, a movie, drinks and dessert, why not give them everything they want in a single location.
Marcus has dropped more than $4 or 17% since I sold my position last September and the company is much cheaper now with a P/E of 18.45, a P/S of 1.83 and a dividend yield of 1.7%, which is in line with the average dividend yield of the S&P 500. Based on how Marcus defines its fiscal year, its first quarter extends from June through August and is likely to benefit from strong box office receipts this summer even though it does not include the Memorial Day weekend like it did last year. The company mentioned this when it said “At this point in the summer, our theatre box office at comparable theatres is about even with last year, except that last year included the Memorial Day weekend, which we don’t have this year. The newly acquired theatres continue to perform as expected. Early summer films such as Ocean’s 13, Knocked Up, Fantastic Four: Rise of the Silver Surfer, Live Free or Die Hard, Ratatouille and Transformers opened well and Harry Potter and the Order of the Phoenix and The Simpsons Movie had blockbuster openings in July. We are hopeful that the remaining films of the summer, including The Bourne Ultimatum and Rush Hour 3, will result in a strong ending to our first quarter of fiscal 2008″.
I expect Marcus to report a stellar numbers when it reports first quarter results in late October or early November and am going to start a position in Marcus despite my slightly negative outlook for the market. I will also start a position in my personal portfolio after this blog entry is published.
This is the second of three blog posts covering the three stocks that almost made the cut for the September 2007 newsletter.
About six months ago a subscriber suggested a micro cap biotech company called Lipid Sciences (LIPD) that he felt had a great story and was trading for less than $1.50 per share. In his words this company should have been pre IPO but they became public through a reverse merger with an Arizona public shell company called NZ Corporation. From what I could read on the Lipid Sciences website, the story indeed seemed very interesting with the company attempting to remove “select lipids– such as cholesterol and triglycerides–from lipoproteins and lipid-coated infectious agents”. In laymen’s terms this translates into treating heart disease and highly infectious diseases like HIV or SARS by selectively removing fat soluble molecules called ”lipids“. Since my background is in technology, I could not really asses if their research had commercial potential and if the story was indeed as good as it sounded.
I convinced my friend Hatim Zariwala, who recently completed his Ph.D in Neurosciences from one of the top neuroscience institutes in this country, to take some time off from inserting electrodes into rat brains and look at Lipid Sciences. Given below are some of his thoughts about the company.
The estimated overall antiviral market in the world is roughly $16 billion (conservative projection) and that of cardiovascular care $22 billion (US only) and ever growing in the developing countries like China, India and Russia. The cardiovascular care is complementary to therapy for obesity, stroke and diabetic care.
After getting Hatim’s thoughts, I also checked with another senior scientist who has years of experience advising senior management at biotech companies and is well on his way towards developing a new drug through his own pharmaceutical company. His thoughts on Lipid Sciences were that the company is targeting an area of research that is so vast and with so much potential that it is usually done by either government funded agencies or universities. He also told me that in more than five years the company has not even reached phase 1 clinical trials and that is not very encouraging.
Management has been done a great job of keeping a lid on operating expenses and based on its current rate of cash burn of approximately $11 million per year, the company has enough cash on hand to last through the middle of 2008. I was looking at Lipid Sciences as nothing more than a call option that expires in mid 2008 but based on the feedback of the two scientists I consulted, even this call option appears to be expensive. The stock had dipped to as low as $1.03 just a couple of days ago and is dangerously close to getting a deficiency notice from the Nasdaq, which is triggered if a stock trades below $1 for 30 consecutive days.
I hope that Lipid Sciences eventually goes on to become successful and I will continue watching this company like I have done for the last six months but I would prefer to do so from the sidelines rather than have my money on the line.
This is the first of three blog posts covering the three stocks that almost made the cut for the September 2007 newsletter.
Over the last six months I have had a chance to research and purchase a few laser and inkjet printers made by Dell (DELL), HP (HP) and Canon (CAJ). As many of you are aware, manufacturers make their money on inkjet printers through the refill cartridges and sometimes use the actual printer as a “loss leader”. A good example of this was Dell giving away printers for free along with the purchase of a computer. Consumers buying printers for personal or light business use prefer inkjet printers because the initial cost is low and the quality of color prints is much better. With the widespread use of digital cameras, more and more people are buying inkjet printers to print pictures at home.
I recently purchased a Canon PIXMA MP600 inkjet printer for light home office use and was very satisfied with both the quality and functionality offered at such a low price. I also happened to notice that the stock of ink cartridges for this Canon printer was low at my neighborhood Circuit City and these cartridges also happened to be one of the top ten best sellers at Amazon.com under the electronics section. The fact that this printer won PC Magazine’s reader’s choice award may have something to do with this. While this can be construed as nothing more than anecdotal evidence of demand for Canon’s printers and ink, consider the fact that Canon recently announced plans to open a factory to manufacture printer cartridges.
Canon cameras hold 8 out of the 10 spots on Amazon.com’s top 10 best sellers list under the cameras and photo category. Incidentally I happened to purchase a Canon PowerShot Pro S3 IS camera for someone at work just a few months ago. Canon has done a great job covering the low, mid and high end segments of digital cameras with its Digital Elf SD 1000 7.1 MP camera, the Canon PowerShot Pro S5 IS 8.0 MP camera and the Canon Digital Rebel 10.1 MP SLR camera.
As an investor, I started looking into Canon’s stock as a potential investment and candidate for the September investment newsletter and liked what I saw. Canon currently trades at a current P/E of 16.11, a forward P/E of 14.45, a P/S ratio of 1.79, sports a 1.6% dividend yield, has a rock solid balance sheet with $10.84 billion in cash and investments and only $262 million in debt. The company not only grew both revenue and earnings by 11% and 20.8% respectively in the first half of 2007, it raised its full year operating profit forecast to $7.44 billion representing year-over-year growth of 18%.
But wait a minute, haven’t the days of double digit growth in digital camera passed us by and aren’t we worried about the US consumer cutting back on spending with the weakness in the housing market? While the original assumption was that sales of digital cameras would grow in the single digits, it turns out that these assumptions were revised upwards for growth of 15% following strong sales of digital cameras in the first half of the year. The fact that some people are buying a second or third digital camera to replace their earlier less powerful models was cited as one of the reasons behind this trend. A cautious US consumer who can no longer use his/her home as an ATM machine will indeed impact most consumer electronics companies and retailers but I think the market has already priced some of this risk into the stocks of these companies. Canon also does not derive a majority of its revenue from the US as you can see from the revenue breakdown table given below,
|Canon Revenue Breakdown By Country
Canon is making a major push into developing markets like India. As investors in Nokia have come to realize, a second wave of product adoption from emerging markets like India, China and Africa can be extremely beneficial. I bought Nokia (NOK) exactly two years ago based on increasing market share driven by sales in emerging markets and the stock is up more than 100% at this point without taking dividends into account.
If everything looks so good, why did I hold off on featuring Canon in this month’s newsletter? Canon and other Japanese companies have been in a major downtrend in the last few days as the Yen has appreciated in value against both the US dollar (USDJPY=X) and the Euro (EURJPY=X). Every 1 yen move against the US dollar in the second half of 2007 is estimated to have a $41.74 million impact on Canon’s operating profit and a similar move against the Euro is going to have a $27.83 million impact on operating profit assuming a conversion rate of 115 yen per US dollar. At the current exchange rate this amounts to a 5% reduction of expected full year operating profits. Japan is also going through a period of political turmoil with its Prime Minister Shinzo Abe quitting office amidst scandals and low voter support. In this environment it may be prudent to wait a little and I am going to add Canon to our watchlist for now and start a position when the market turmoil in Japan quietens down a little.
As mentioned in the June investment newsletter, I strongly considered featuring a company and started writing about it but ended up rejecting the idea at the last moment and instead decided to feature Gymboree (GYMB). This company was Carter’s Inc (CRI), the maker of baby clothes that is most likely to benefit from the “new baby boom”, which I discussed in the July 2006 edition of SINLetter.
Carter’s, which has traditionally been a wholesales company, has diversified into retail with a two-pronged strategy that could bode well for the company. Carter’s increased its retail exposure by acquiring OshKosh in July 2005 and by developing sub-brands called “Just One Year” and ”Child of Mine” for Target (TGT) and Walmart (WMT) respectively. Debt levels have dropped when compared to last year, the company is buying back stock and reported better than expected results in the first quarter of 2007.
I cannot say I am thrilled by Carter’s decision to buy OshKosh, as the OshKosh division seems to be losing market share to competitors like Children’s Place (PLCE) and Gymboree (GYMB). This was evident from first quarter 2007 results where the Carter’s division had revenue growth of 10.6% while revenue actually fell 0.2% at the OshKosh division. This compares with first quarter revenue growth of 12% at Children’s Place (PLCE) and 12.6% at Gymboree (GYMB). They say that one quarter does not make a trend but this is the third consecutive quarter where year-over-year sales have fallen at OshKosh. Both retail and wholesale margins at OshKosh were also negative in Q1 2007. Given this trend of declining sales, I am baffled by management’s plans to open 5 new OshKosh stores in 2007.
The $344 million in debt that Carter’s carries on its balance sheet combined with declining sales in the OshKosh division made me take a closer look at competitor Gymboree for all the reasons mentioned in the newsletter.
The other stock I considered for the June 2007 newsletter was fitness equipment maker Nautilus (NLS). After lowering their first quarter and full year 2007 forecast and reporting terrible first quarter results, the stock has taken a bad beating in recent weeks. The major risk the company faces is the cooling of the red hot real estate market that has in turn dampened consumer enthusiasm for big ticket items like the Bowflex home gym and StairMaster products that Nautilus sells. This was cited as one of the primary reasons for net income dropping more than 50% in the first quarter. Given my negative outlook of the housing sector since late 2005, I have held back on adding Nautilus to the SINLetter model portfolio despite writing about it in the past.
With a dividend yield of 3%, a high short ratio of 12, a forward P/E of 11.26 and a forecast of 20 to 30% earnings growth in 2007, the company remains near the top of my watch list. The company has also started supplying fitness products to commercial gyms. In an interesting development, buyout firm Sun Capital recently increased its stake in Nautilus.
The key to Nautilus going forward is its Pearl Izumi and Nautilus branded apparel lines. I would like to see how sales growth in apparel shapes up before starting a position in Nautilus but given the bearish sentiment surrounding this stock, any small piece of good news is likely to cause it to go up in a hurry.
The focus of the April 2007 edition of SINLetter was spinoffs and I only considered companies that had either been spun off from a parent or were planning on spinning off a subsidiary. Hence I decided to feature EMC Corp (EMC) and Sally Beauty Holdings (SBH) in the April investment newsletter and very briefly looked into two other companies.
A subscriber suggested one of these companies to me and it is a REIT called American Home Mortgage Investment Corp (AHM). According to this subscriber, the subprime mortgage meltdown has adversely impacted other companies in the mortgage industry even though they have strong fundamentals and AHM happens to be one of these companies.
AHM has lost more than 25% of its value year-to-date even though it has very little exposure to the subprime market (less than 2% of its business) and insiders who already own 20% of the company have been buying shares on the open market. This company also had an annual dividend of $4.48 or a yield of over 17%. I asked a contact of mine in the mortgage industry about the company and he thought it looked like a solid company. However the reason I decided not to feature American Home Mortgage Investment was because of my continued negative outlook on the housing and mortgage industries. As I mentioned in the April newsletter,
“the sector is not likely to recover this year and any bounce in home builder or mortgage lender stocks is likely to be a dead cat bounce”
This is the reason I still hold put options on the mortgage lender Countrywide Financial (CFC) and I would have contradicted myself by starting an investment in AHM at this time. My caution about AHM appears to have been well founded since the company reduced its first quarter and full year 2007 forecast today and cut its dividend to 70 cents a share, dropping the dividend yield to 10.84%. The company was also downgraded by Bear Sterns analyst Scott Coren yesterday. I am going to continue exploring AHM and if I feel that the mortgage industry is near a bottom (it is impossible to call the absolute top or bottom), it may make it into a future edition of SINLetter.
The other company I briefly considered was one of the surviving CLECs Covad Communications (DVW). I recently had to purchase a dedicated T1 internet line for a business and I found that Covad had an excellent rate and a very friendly and knowledgeable sales team. I was intrigued by the possibility that Covad may make a comeback like CMGI did this year. The focus of the company used to be wholesale telecommunication services provided through partners like AT&T, AOL and Verizon but over the last three years, the company has shifted its focus to the retail side. Retail now accounts of 38% of total revenue when compared to just 5% three years ago according to Chris Dunn who used to be Covad’s CFO until he resigned on Tuesday.
An excellent rate for the consumer usually means low margins for the company and I was not surprised to see that the company has been posting losses for the last three years despite posting revenue gains every year. While the balance sheet is not as debt laden as its pre-bankruptcy days, it still has $173 million in short and long-term debt when compared to $81.5 million in cash and short-term investments. The company’s 2006 purchase of fixed-wireless internet service provider NextWeb is going to strengthen its retail focus and give it a foothold in the rapidly growing wireless ISP space. However the company expects to post a wider loss of $15 to $39.5 million in 2007, despite continuing to grow revenue and I decided to put Covad on the back burner for now.